چکیده انگلیسی

I show that the price discounts of Chinese cross-listed stocks (American Depositary Receipts (ADRs) and H-shares) to their underlying A-shares indicate the expected yuan/US dollar exchange rate. The forecasting models reveal that ADR and H-share discounts predict exchange rate changes more accurately than the random walk and forward exchange rates, particularly at long forecast horizons. Using panel estimations, I find that ADR and H-share investors form their exchange rate expectations according to standard exchange rate theories such as the Harrod–Balassa–Samuelson effect, the risk of competitive devaluations, relative purchasing power parity, uncovered interest rate parity, and the risk of currency crisis.

مقدمه انگلیسی

For two decades, Chinese companies have been allowed to issue A-shares at domestic stock exchanges and to list their shares at international stock exchanges such as H-shares in Hong Kong or American Depositary Receipts (ADRs) in the United States. At the microeconomic level, companies may benefit from cross-listing abroad by increasing the valuation of their stocks relative to domestic rival firms (Melvin and Valero, 2009), by reducing the share of voting rights held by controlling shareholders (Ayyagari and Doidge, 2010), by becoming more immune to the effects of currency crises (Chandar et al., 2009), or by improving investor protection and corporate disclosure (Roosenboom and van Dijk, 2009). At the macroeconomic level, cross-listing may lead to a more integrated domestic capital market with positive spillover effects, such as lower equity costs, even for non-cross-listed companies (Fernandes, 2009).
As A-shares and cross-listed stocks of the same Chinese company generate an identical stream of cash flows, both types of stocks should exhibit the same price in exchange rate-adjusted terms (Chan et al., 2008a). In perfect capital markets, deviations from this “law of one price” should be arbitraged away. However, numerous papers find that the simple fact that both types of stocks are traded at different stock exchanges can lead to market segmentation. Several of these papers show that cross-listed stocks are more correlated with the stock market on which they are traded than the one on which their cash flows are generated (Froot and Dabora, 1999, Chan et al., 2003 and Chan et al., 2008a).1
Capital controls or ownership restrictions can lead to a permanent violation of the law of one price between domestic and cross-listed stocks since cross-border arbitrage can not take place (Melvin, 2003, Levy Yeyati et al., 2004 and Auguste et al., 2006). Similar to capital controls, ownership restrictions prevent arbitrage between both types of stocks from taking place. Chinese ownership restrictions, for example, prevent domestic investors from buying cross-listed stocks and international investors from buying domestic stocks leading to ADR and H-share discounts of up to 95% relative to domestic A-shares from 1998 to 2006 (Arquette et al., 2008). Given the large and persistent deviations from the law of one price, a literature has emerged that examines the determinants of price discounts on Chinese cross-listed stocks. B-share2 discounts relative to A-shares are found to be driven by: the low risk aversion of Chinese investors (Ma, 1996); the low liquidity of B-shares relative to A-shares (Chen et al., 2001); information asymmetries (Chakravarty et al., 1998, Chui and Kwok, 1998 and Chan et al., 2008b); and, the availability of other types of cross-listed stocks (Sun and Tong, 2000). H-share discounts relative to A-shares are found to be driven by: investor sentiments3 (Wang and Jiang, 2004, Arquette et al., 2008 and Burdekin and Redfern, 2009); liquidity conditions (Wang and Jiang, 2004); and systemic risk premiums (Li et al., 2006).
Arquette et al., 2008 and Burdekin and Redfern, 2009 find that a significant part of ADR and H-share discounts can be explained by changes in the non-deliverable yuan/US dollar forward exchange rate. Their finding suggests that ADR and H-share investors take the risk of future exchange rate changes into account when pricing cross-listed stocks. This finding relates to papers that examine how exchange rates affect ADR returns. Since ADRs are denominated in US dollars and their underlying stocks in the domestic currency, these papers find that a depreciation of the domestic currency against the US dollar leads to falling ADR returns (Kim et al., 2000, Bailey et al., 2000, Bin et al., 2004 and Grammig et al., 2005).4
I contribute to the literature in two ways. First, I show that the relative prices of cross-listed ADRs and H-shares and their underlying A-shares can be used as an indicator of exchange rate expectations. Since China has imposed capital controls and transnational ownership restrictions, cross-border arbitrage cannot take place and the law of one price between A-shares and cross-listed stocks is thus not binding. I argue that ADR and H-share investors will align the relative prices of yuan-denominated A-shares and US dollar-denominated ADRs or Hong Kong dollar-denominated H-shares with their expectation about the future yuan/US dollar exchange rate rather than with the current official exchange rate. Using a rolling regressions forecasting framework I find that ADR and H-share discounts have a better ability to predict changes in the yuan/US dollar exchange rate than the random walk or forward exchange rates, at least at forecast horizons longer than one year.
Second, I investigate the determinants of ADR and H-share investors’ exchange rate expectations. China makes a good case to study the validity of exchange rate theories since the yuan was pegged to the US dollar until July 20, 2005 and heavily managed afterwards. This implies that the official exchange rate does not (in the peg regime) or much less (in the managed floating regime) react to changes in macroeconomic fundamentals than one would expect under free market conditions. I study the validity of exchange rate theories by testing the impact of macroeconomic fundamentals on the exchange rate expectations ADR and H-share investors form under free market conditions. Using panel data on 22 ADR/A-share stock pairs and 52 H-share/A-share stock pairs from December 1998 to February 2009 I find that ADR and H-share investors expect more yuan appreciation against the US dollar: if the yuan’s overvaluation decreases (the incentive of competitive devaluation); if the inflation differential vis-à-vis the United States falls (relative purchasing power parity); if the productivity growth in China accelerates relative to the United States (the Harrod–Balassa–Samuelson effect); if the Chinese interest rate differential vis-à-vis the United States decreases (uncovered interest rate parity); when Chinese domestic credit relative to GDP decreases (lower risk of a twin banking and currency crisis); or, if Chinese sovereign bond yields fall (lower risk of a twin debt and currency crisis), ceteris paribus. The results suggest that ADR and H-share investors form their exchange rate expectations in accordance with standard exchange rate theories.

نتیجه گیری انگلیسی

I show that the price discounts of ADRs and H-shares to their underlying A-shares can be used as an indicator of ADR and H-share investors’ expectations of the future yuan/US dollar exchange rate. Using a rolling regressions framework I find that during the recent float period (July 2005 to February 2009) ADR and H-share discounts are more accurate in predicting changes in the yuan/US dollar exchange rate than the random walk or forward exchange rates, at least at long forecast horizons. Using a panel framework, I find that many macroeconomic variables which – theory has shown – determine exchange rates also have a significant impact on ADR and H-share investors’ exchange rate expectations. I find that ADR and H-share investors form their exchange rate expectations according to the Harrod–Balassa–Samuelson effect, the risk of competitive devaluations, relative purchasing power parity, uncovered interest rate parity, the risk of a twin banking and currency crisis, and the risk of a twin debt and currency crisis.
The results have implications for academics and practitioners. The forecasting exercises show that ADR and H-share discounts are helpful to predict changes in the yuan/US dollar exchange rate, at least at long horizons. The PBoC might use the changes in ADR and H-share discounts to measure the market-determined exchange rate expectations and to determine possible misalignments of the exchange rate. The upward trend in ADR and H-share discounts prior to the float of the yuan in July 2005, for example, indicated that ADR and H-share investors expected a revaluation of the yuan against the US dollar. The PBoC may take advantage of ADR and H-share discounts to manage the timing and intensity of foreign exchange market interventions and realignments. Investors may use ADR and H-share discounts to speculate on exchange rate movements (particularly in the long run). The forecasting models indicate that ADR and H-share discounts are more accurate than forward rates in forecasting exchange rate changes. If, for example, ADR and H-share discounts indicate more (less) yuan appreciation against the US dollar than suggested by the forward rate, a potentially profitable trading strategy may be to buy (sell) yuan against US dollars at the forward market and make the reverse transaction at the spot market at maturity. The panel regressions show that the theoretical links between macroeconomic variables and exchange rates in most cases also apply to exchange rate expectations. This supports the validity of many exchange rate theories and substantiates the rationality of stock market investors’ expectations. What is more, my approach provides an opportunity to study exchange rates in managed floating regimes. The yuan/US dollar exchange rate is heavily managed by the PBoC, which implies that it is not the ideal measure to test exchange rate theories. ADR and H-share discounts, on the contrary, enable one to study the impact of macroeconomic events using exchange rate expectations formed under free market conditions.